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New choices in the marketplace, means banks and credit unions may struggle to maintain market share for their checking accounts. One solution is to update outdated free checking accounts to a fee-based model. This fee income strategy simultaneously increases revenue and delivers these value-added services to customers. Find out more from this short Thought Leader Video from the Financial Managers Society then click here where you can join one of our upcoming Fee-based Income webinars and learn more about this strategy for change from your friends at IZALE.

by Todd Taylor, CPA & CFA, Taylor Associates

From the end of 1992 to the beginning of 2018, net interest margins in the financial institutions industry have declined 100 basis points, with earning asset yields declining from 8.1% to 4.2%, and funding costs falling from 3.8% to 0.5%. This margin compression has been offset by either lower credit losses and/or lower net non-interest expense. So the question remains, where do margins go from here?

As the yield curve flattens, the focus shifts to earning asset yields and whether institutions will be able to pass along increases in the Prime Rate

and other rates along the yield curve. We will examine factors impacting earning asset yields and suggest strategies to stabilize risk-adjusted returns.

What's In the Mix

It is interesting to point out that large institutions (80% of the loan market), have loan to asset ratios near historical lows while community institutions are moving back to pre-crisis levels as their ability to generate fee income has not kept pace with the large institutions.

Behind the Curve

The Fed has raised rates 175bps and is expected to increase them 125-150bps by year end 2020. The Fed's DOT plot indicates they intend to lower rates over the long-term, averaging 2.75%, so adding duration to your earning assets isn't necessarily a bad thing. The challenge comes in identifying assets that compensate you for the remaining rate increases, but also protect you in the event that short term rates don't increase. Most floating rate and amortizing assets don't fit this profile. Prime Loans to Go

With quality loans hard to find in the expanding economy and institutions hungry for even more loans to meet budget, some institutions have relied on traditional indirect channels to drive loan production while others have ventured into non-traditional fintech platforms to boost lending. This new growth into out-of-market signature lending is further increasing credit risk.

Conclusion

We are definitely in uncharted territory, with massive amounts of stimulus being removed from the system, funding costs accelerating and earning asset yields struggling to come off their lows. If your institution is experiencing or is concerned about earning asset yield compression, feel free to contact Taylor Advisors to learn about how we strategize prosperity. A final word of advice: Stay disciplined when evaluating unproven lending practices just to meet budget. Don't forget what happened to all those stated income prime & sub-prime loans. When extending terms on assets, reserve them for the highest quality borrowers and incorporate a call protected barbell strategy in the investment portfolio to improve duration-weighted returns.

Note From Scott Richardson, IZALE Founder & CEO:

Featured Expert this quarter, Todd Taylor CPA, CFA, is Founder and President ofTaylor Advisors. I've known Todd for almost 20 years. After working in banks, he founded Taylor Advisors in 2002. They are an SEC Registered Investment Advisor and a balance sheet consulting firm serving financial institutions, including banks and credit unions. Todd has spoken at numerous state and national conferences on balance sheet management, investments, and risk management. He has written several articles for industry publications on capital, liquidity, investments, and more. Don't hesitate to contact Todd if this article triggers a question or two, or you just want to comment on it.

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​Effective June 9, 2017, all individuals who provide advice to retirement plans, including Individual Retirement Accounts (IRAs), must abide by the fiduciary standard. What does the fiduciary standard mean? This means that your advisor must put your interests first before their own or that of the firm, make prudent recommendations, charge reasonable compensation and make no misrepresentations to you regarding recommended investments. The recommendations made by your advisor must be based upon your specific investment needs and objectives. The fiduciary standard is applicable to any recommendations that your advisor makes to you, the client, for your retirement account.

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